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Chinese government’s announcement to open bank cards network market

On Oct. 29, 2014, in a routine working session, the China State Council determined that the Chinese government would “open” bank card acquisition and settlement businesses in China. Qualified Chinese domestic and foreign investors may apply to establish bank card acquisition and settlement businesses in China and to process Chinese domestic bank card transactions. The Council also determined that foreign bank card organizations which only provide foreign currency settlement services for cross-border transactions may process cross-border bank transactions without the need to establish an in-China bank card acquisition and settlement subsidiary.

The Council’s actions have received favorable feedback, particularly from foreign bank card payment networks, but are these actions really something to applaud yet, in the context of today’s legal and business reality in China?

The China UnionPay network (UnionPay Network) was initially established by the Chinese government through a serial of administrative documents issued by the People’s Bank of China as a product of the “Gold Card Project.” Therefore, strictly speaking, the UnionPay Network was not established as a market choice but by the administrative power of the Chinese government. In the early days, the UnionPay Network operated as a non-profit network and undertook certain administrative functions to connect the State-owned banks in China. The commercialization of the UnionPay Network began in 2002 when the China UnionPay Company Limited was established.

In fact, there is no law or regulation that defines, from the legal perspective, the bank card payment network business in China or officially grants any exclusive status to the UnionPay Network. As a result, it has been impossible for anyone else to obtain a government permit in China to engage in such a business and, as a practical matter, the UnionPay Network has been the only bank card payment network that receives recognition from the government.

However, every coin has two sides. Because of the unique status of the UnionPay Network, privately owned third-party internet payment processors in China rebel against it, claiming its network fees are excessive and result from its de facto monopoly. They circumvent the UnionPay Network fees by establishing direct connections with individual banks through commercial contracts. It is a slow and unpleasant process for the third-party internet payment processors, but, after years of effort, they each have established and maintain a network of connections with certain domestic banks. For example, as of today, Alipay has connections with more than 20 banks in China. Such privately owned networks, although not technically recognized by the government, create strong commercial competition against the UnionPay Network.

Although the commercialization of the UnionPay Network began in 2002, due to its unique positioning (public service vs. purely commercial operation) by the government, the process has been staggered and subject to restriction. For example, as of today, the power to determine network fees charged by the UnionPay Network is still in the hands of the People’s Bank of China, not China UnionPay. In comparison, the privately owned internet payment processors have been totally market driven since they were born and they offer better deals to share the payment service proceeds with the banks without any government supervision. Because there is no law or regulation governing the bank card acquisition business in China and there is no administrative regulation of direct connection with the banks, the privately owned processors have enjoyed conducting business in a regulatory vacuum. Such a situation has put China UnionPay at a competitive disadvantage with those third-party payment processors.

Although the government professed neutrality in that competition, it created the environment which actually favors privately owned payment processors because, in that regulatory vacuum, those processors can strike deals with the banks while China UnionPay could not. China UnionPay has repeatedly and intensively advocated at various public events in the past two years that the playing field should be leveled in the payment processing business in China. Although the audience of such advocacy seems to have been the third-party payment processors, it actually was not. The true audience has been the government, and through such advocacy China UnionPay has reminded the government that China UnionPay was hobbled by its government legacy, which restrained its full commercialization. The message finally has been heard, and China UnionPay recently has released several operational documents requesting banks to disconnect from third-party payment processors. Now, the tables have turned on those payment processors. It is their turn to worry about their direct connection approach and advocate for fair play, anti-monopoly and administrative regulation.

In this context, let us revisit our question at the beginning of this post, as to whether the State Council’s actions on payment network processing business should be applauded, by reviewing the status of each of the industry players.

China UnionPay

In light of the current level of competition from third-party payment processors in China, China UnionPay probably has already accepted the fact that bank card payment networks, other than the UnionPay Network, will be recognized in China. China UnionPay may well be hoping that forthcoming law and/or regulations will include (1) minimum capital and other requirements for industry entry, such that some smaller third-party processors will lose the opportunity to stay in the business; (2) clear regulatory requirements and rules, such that the licensed third-party payment processors will be subjected to comparable regulatory scrutiny; and (3) that the “State-owned” feature of the UnionPay Network will be recognized somehow, such that it will have more latitude to deal with the competition.

Third-Party Payment Processors

Regardless of whether the third-party payment processors are recognized by the government or not, they already operate their own direct connection networks and have been enjoying the regulatory vacuum described above. They do not need any new law or regulation to conduct business, as this business is already open to them. Any further liberalization will only invite stronger competition from international bank card payment networks. The third-party payment processors have more to lose than gain from new law or regulation. That said, the small minority of substantial, existing, Chinese third-party payment processors, who will clearly stay in business after the new law or regulation, may benefit from new legitimacy resulting from it and may use that new legitimacy to combat efforts by China UnionPay to cause such processors to disconnect from the banks with which they have negotiated direct connection networks.

International Bank Card Payment Networks

This is the group that has the strongest will and biggest motivation to see new payment processing law or regulation in China because they want and will have their share in an important market, to which they currently have no access. However, they will still need to be patient for such a new law or regulation to become a reality. The third-party payment processing business was opened in China in 2010 by special regulation, and that business has not been opened to foreign investment yet. The opening of the bank card payment network business will definitely have more impact and on a bigger scale than the opening of the third-party payment processing business. This means that the Chinese government will have to balance more interests and calm the resistance from both China UnionPay and the existing privately owned third-party payment processors for such an opening to occur. Therefore, it will likely be a very aggressive expectation that opening of the bank card payment network business to foreign investment will take place before the opening of the third-party payment processing business.

In essence, if applause is due, it should be muted. The topic of opening the bank card payment network business in China was only discussed in a routine working session of the Chinese State Council. The discussion was forward looking, and needs clearly defined regulation to realize its goal. There will likely be a long way to go before the discussion becomes a special law or regulation to open such a business. International bank card payment networks should be patient to allow the process to occur, but may want to proactively advocate for their interests in the process and make proper business preparations for the opening, when it eventually does occur.

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